Dorfman: Market Capitulation Looming Threat

In today’s New York Sun, Dan Dorfman argues that market commentators, fixated by this week’s Wall Street tumult, may be ignoring an even larger danger: market capitulation, a la 1987:

Lost in the intense focus on the current financial crisis is a major new market risk that appears to be developing — investor capitulation, a situation in which many investors, fed up with mounting losses, say enough is enough and throw in the towel. While such capitulation helps clear the air, over the short term it’s often a forerunner of big declines in stock prices and even market crashes.

To bolster his argument, Mr. Dorfman interviews Gary Wollin, of Gary Wallin & Co., which manages more than $100 million of assets:

Mr. Wollin characterizes this past Monday’s 504-point skid as a signal it’s going to get a lot worse over the short term. “There may be a bounce-back rally” — the Dow did rise 410 points yesterday — “but it won’t last because the bleeding hasn’t stopped,” he says. “The problem is every time you put your finger in the dike, there’s another hole.”

He says he’s especially concerned about housing, which he contends is still overvalued. “The people who own homes just don’t get it when they try to sell,” Mr. Wollin says. “They believe Wall Street may be a bubble, but never real estate.” He says rising unemployment, now at 6.1% and heading to 7.5% before year end, he predicts, also disturbs him because he sees it playing increasing havoc with the economy. The prospects for many earnings disappointments and the uncertainty about what actions a new administration might take to clean up Wall Street are also of concern, Mr. Wollin says.

As for banking’s crisis, he says he views commercial real estate as the next bombshell. Presently, there are 117 problem banks on the Federal Deposit Insurance Corp.’s watch list. Given broad bank exposure to commercial real estate loans, Mr. Wollin says, the number could easily swell to 500 to 600 if that business should experience the same woes that befell residential housing.

He envisions even bigger financial troubles in the banking industry, including not only names in the news such as Washington Mutual and Wachovia, but also Citicorp, HSBC, and even Bank of America.

Mr. Weiss says he feels Bank of America is making a “horrendous mistake” in acquiring Merrill, as it’s already bogged down with its earlier purchase of mortgage-lending giant Countrywide Financial, which he describes as “a classic pig in the poke.” Now on top of that bad move, he observes, Bank of America is taking on all the debts and risks of Merrill.